The SET Index has finally moved above 1,700 points, the 2017 target that we set at the end of last year. We look for upward revisions in 2018 SET targets soon for many research houses (our call is 1,900).
That may seem an impossible dream for some, as it has been more than two decades since the SET approached that level -- it reached an intra-day high of 1,789 on Jan 4, 1995. While this level is uncharted territory for younger investors, their older peers still get flashbacks of the nightmare of the great crash that followed.
Are we seeing another asset price bubble forming? Possibly, but most likely not.
In the world of prolonged low interest rates, lower funding costs and relatively unattractive returns from fixed-income instruments, inevitably we will see "yield-seeking" behaviour. Investors are likely to be more willing to take on riskier assets at higher prices, implying a lower return on investment, and to leave a thinner buffer against any hiccup that affects their growth assumptions.
But looking at asset prices alone is only half the story and is not enough to justify pushing the panic button. "Expensiveness" is a relative concept. We cannot say with absolute certainty that a 10-million-baht condominium is more "expensive" than a 5-million-baht one unless we compare size, location and other key parameters. For the same reason, a SET index of 1,700 today cannot be compared directly with 23 years ago unless we take into account earnings and other fundamental factors in the financial market.
There are two major factors that make this SET rally very different from the 1994 peak: earnings and low interest rates.
The current market rally is well supported by fundamental corporate earnings. The SET's earnings per share (EPS) are currently around 95 index points, compared with 60-70 points during the 1994 episode. The price-to-earnings ratio (PER) is around 18.5 times, compared with nearly 30 times in 1994.
Some may argue that a PER of 18.5 times is high compared with the SET's 40-year average of 12.5 times. This brings us to the second supporting factor -- low interest rates.
To illustrate the relationship between interest rates and market valuation, let us look back in time. In the 1980s and 1990s, local commercial banks offered a deposit interest rate of around 5%. To provide an attractive return relative to risk-free deposit rates, the equity market must trade in a lower PER range. Back in the 1980s, the SET commanded a PER valuation of only five to 12 times.
For the last 17 years, Thailand's 10-year government bond yield has been moving down, going from 8% in 2000 to 4% in 2010, and 2.5% in 2017. It is thus unsurprising that the PER of the SET has over the same period risen from an average of 10 times (from 2000-05) to 12.5 times (from 2005-2013), and has been moving toward 15 to 20 times for the past few years.
The low interest rate environment is one of the key factors behind the rising market valuation. Lower interest rates are normally associated with yield-seeking behaviour. We expect equity market valuations to sustain a higher PER for longer as interest rates are likely to remain low for the foreseeable future. The Bank of Thailand is unlikely to raise its policy rate anytime soon given the strength of the baht, still-fragile domestic demand, high household debt and relatively mild inflationary pressure.
One important point to keep in mind: market valuations (PER multiples) are subject to changes in sentiment (risk appetite) and changes in other parts of the financial market landscape, such as bond yields, economic growth, or industry-specific growth drivers. The higher the valuation, the bigger the risk of a correction should there be any hiccup in underlying assumptions, especially ones that affect earnings and growth. Therefore, at the current index level and valuation multiples, it is more important than ever to stay focused on the earnings outlook.
The focus of our near-term actionable investment strategy for the upcoming third-quarter earnings season (which begins this week) starts with the banking sector. At SCBS, we expect aggregate bank earnings to grow 13% quarter-on-quarter (implying near-zero growth year-on-year), primarily driven by lower provisions as non-performing loans (NPLs) are easing. While we expect pre-provision profit to be fairly lacklustre given weak quarterly loan growth, narrower net interest margins and stagnant non-interest income, we believe it could be a good opportunity to accumulate bank shares for longer-term gain.
Banks stand to benefit from the new investment cycle, driven by the Eastern Economic Corridor, the government's flagship investment project. Macroeconomic indicators such as export growth and strong tourist arrivals are supportive for improving asset quality going forward. Also, banking sector valuations are among the biggest laggards against the SET. Our tactical top picks based on the theme noted above are BBL, KTB and TMB.
Pornthep Jubandhu is senior vice-president of SCB Securities.